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The Monetary Policy Committee

Interest rates are in the news these days. The four quarter point rises between August 2006 and May 2007 have brought the base rate of the Bank of England firmly back into the news as the effect on people’s pockets in terms especially, of mortgage repayments, has been hard.

Things are expected to get tougher. Another quarter point rise is expected in July, taking the base rate to 5.75%, and it is widely forecast that they will reach 6% by the end of the year, which would be their highest level since January 2001.

Making it even more likely that a quarter point rise will come in July is the news that the Bank only narrowly decided not to increase rates to 5.75% in June.

But who sets the rate? And how and on what basis?

The interest rates are sent by the Bank of England’s Monetary Policy Committee (MPC) which sets a rate it judges will enable the target for inflation to be met.

There are nine members of the MPC: the Governor, the two Deputy Governors, The Bank’s Chief Economist, The Executive Director for Markets and four external members who are appointed directly by the Chancellor of the Exchequer. The purpose if the latter four appointees is to ensure that the MPC gains benefit from expertise and thoughts from outside of the Bank.

Members are independent and do not represent groups or political parties. Each member has a single vote on interest rates – one member, one vote. The decision on interest rates is based on the result of that vote. There is also a representative from the Treasury at the meetings; this representative can discuss policy, but does not have a vote. The two-way brief is to take Government policy thinking to the meeting, and keep the Chancellor informed of monetary policy.

Meetings of the MPC are held monthly to set the interest rate, backed up by continual information from staff at the Bank throughout the month, including a pre-MPC meeting on the Friday before the main MPC meeting. The nine members are kept updated with all up to date relevant economic data and trends around the UK. Agents for the Bank talk directly to business leaders to understand current and future economic prospects.

The monthly MPC meeting last for two days. Day one begins with an update of economic data, and carries on with discussion points. Day two summarises day one’s points and each member explains his view on current policy. The Governor summarises the policy he believes the members want, and any member who disagrees is asked to say what interest rate level they’d prefer.

The decision of the vote is announced at noon on the second day.

Two weeks after the meeting minutes are published, explaining the decisions and thinking behind them, an account of discussions and how each member of the Committee voted. The Committee is also asked to explain its decisions to the Treasury Committee.

Each quarter the Bank publishes an Inflation Report, giving an analysis of the economy, influencing factors on decisions, and forecasts for inflation and output growth. Monetary policy actually has a time lag of about two years so good judgment and forward thinking is required. The MPC used a model of the economy to help with its forecasts.

The current target for inflation is 2%, and the current rate is 2.5%.

Base rates were moved up by 0.25% in May to 5.5%, and left unchanged in June.

Tom Smith
6th July 2007

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